South Asia Economic Update 2010: Moving Up, Looking East

June 7, 2010

South Asia: Smallest Decline in Growth (Enlarge)South Asia's rebound since March 2009 has been strong. South Asia is poised to grow by about 7% in 2010 and nearly 8% in 2011, thanks to the strong recovery in India, good performance in Bangladesh, post-conflict bounce in Sri Lanka, recovery in Pakistan, and turnarounds in other countries, including Afghanistan, Bhutan, and Maldives.

The region's prospective growth is close to pre-crisis peak levels and faster than the high rates of the early part of the decade (6.5% annually from 2000 to 2007). "The recovery is being led by rising domestic confidence and is balanced in terms of domestic versus external demand, consumption versus investment, and private demand versus reliance on stimulus," said Dasgupta.

Intervention at right time
Strong government fiscal and monetary stimulus packages and, in some cases, external assistance are helping stimulate recovery. Improved optimism is helping the recovery in private spending in India, Bangladesh, Bhutan, and Sri Lanka.

According to Dasgupta, World trade recovery is also supporting the rebound in exports and tourism, as are capital inflows. "Not everyone is doing equally well, with slower recovery in countries with weaker fundamentals, those with unresolved conflict or post- conflict issues, and those that were heavily exposed to the global downturn (Maldives, Nepal, and Pakistan)."

Afghanistan is recovering from a drought and is expected to show stronger growth of 7% based on expanding external assistance.

Global Integration
Contrary to current beliefs, South Asia’s particular strengths and forms of global integration—not the lack of it—was a key factor behind its resilience following the financial crisis of 2008. With emerging markets playing an increasing role in driving growth, integration should be a key component of a sustained and inclusive growth strategy going forward, the report says.

Over the past fifteen years the region has become much more open—and it appears that the form of openness it has chosen has provided resilience in the face of recent shocks. "Financial systems proved to be robust with limited exposures to overseas subprime markets. Remittances, exports of goods and services such as in the IT and garment sectors, and foreign direct investments kept up during the crisis," said Dasgupta

At the same time, policy response in most countries played a key role in boosting confidence and accelerating recovery.

One of the key new drivers is likely to be the rise of a globally competitive manufacturing sector. South Asia in recent years has attracted greater investor attention, because of faster growth, its large size of domestic markets, and as an increasingly attractive location for labor-intensive manufacturers given low-wage costs.

Dasgupta said, "And paradoxically, its growing prowess in exports of sophisticated services as it became more open and integrated with global markets is also enhancing its possibilities in industrial and other sectors." Such services will serve as critical inputs to the growth of manufacturing.

However, in countries with weaker fundamentals, unresolved conflict or post-conflict issues, and those that were heavily exposed to the global downturn, such as Maldives, Nepal and Pakistan, slower recovery is taking place (about 4% in 2011 for all three countries).

Managing the immediate recovery
As South Asia‘s recovery gathers momentum, an immediate challenge is to create fiscal space and contain rising inflationary pressures, while ensuring that the exit from fiscal and monetary stimulus is in tune with the recovery of private demand.

Greater fiscal space is needed to deal with unexpected future shocks and permit governments to finance crucial public investments.

Food prices have been rising especially sharply in recent months, because of poor weather in India compounded by delayed adjustment to higher global prices; they should moderate in the near-term, but a renewed focus on agriculture is also vital, especially given the persistently high rural populations and poverty.

The region is facing a very different global economy over the medium term. According to Dasgupta, there is significant consensus now that what will emerge from this crisis will not be simply a return to pre-crisis conditions, but a "new normal."

Developed countries are starting to save more and spend less, are burdened with large fiscal and financial adjustment after, and are likely to grow at a much slower pace, especially in Europe and North America, whereas Asia and emerging markets will become much bigger drivers of global growth.

While high-income markets will continue to be important for South Asia, even if at a slower pace than in the past, other emerging markets and regions are also fast-growing and increasingly important partners. In looking for future drivers, the Update focuses on trade and investment integration opportunities and recommends three principal directions for the countries in the region:

Intensify their Look East strategies to integrate faster with East Asia. Currently
trade between the two regions amounts to $126 billion annually
and could reach $450 billion per year.
Integrate more closely with each other within the South Asia region, to generate
up to $50 billion per year more to the current $20 billion.
Preserve links to high-income markets in Europe and North America, and others,
as these will continue to be important for labor-intensive exports, services, and as
sources of capital and know-how.
Sustaining inclusive and faster growth
"The challenge now is to also make this regional recovery more durable, inclusive and sustained, looking not to just cement its past successes, but to future drivers," said Dasgupta. The world that the region is facing after this crisis is different—with slowing growth in high income countries and faster growth in emerging markets—offering both opportunities and challenges.

The model that has served the region well in the past, the growth of increasingly sophisticated service sectors, should continue to serve it well. But it will be useful to add to that in order to create more jobs and help realize the demographic potential of the region.

South Asia Regional Cooperation
Integrate more closely with each other within the South Asia region is key. The potential for closer integration within South Asia is large (with annual trade potentially increasing by some US$50 billion), similar to the experience in the EU, East Asia and other regional trading arrangements.

The gains from a Look East strategy will be even stronger with such an expanded regional market. "The role of India will be central to improve integration opportunities for smaller neighbors as they respond," said Dasgupta. While the gains for India are smaller, the gains for smaller neighbors are much bigger.

Challenges and Conflict
The South Asia region faces unique challenges such as those stemming from conflict and insecurity which will need to be addressed if the region is to fulfill its full potential. For some countries in the region, and some regions in all countries, economic growth and development has been hobbled in the past decade by rising conflict and insecurity.

“As peace returns, the post-conflict peace dividends can be large but are not automatic; policy settings need to be supportive—potentially raising growth by 2-3% annually in the countries and more in the sub-regions severely affected,” said Dasgupta.

The post-conflict bounce in growth and optimism in Sri Lanka is an example, and could be possible in Nepal, if policies sustain the dividend. In conflict affected areas, winning the peace and ensuring security will require strengthening the role of the state to deliver better services, the creation of jobs, and good governance. More trade among neighbors might help.